An Efficient Frontier for Retirement Income by Dr. Wade Pfau
(Social Science Research Network)
When I
questioned Dr. Pfau about what he and his co-authors meant by the
statement, "clients may wish to consider their retirement income
strategies more broadly than relying solely on systematic withdrawals
from a volatile portfolio" in the paper "The 4% Rule is Not Safe in a
Low-Yield World" (see below), he responded by referring me to this new
paper to be published in the February issue of The Journal of
Financial Planning.
The paper
uses Monte Carlo simulations and "current market" assumptions to
determine an efficient frontier of investment allocations that best meet
the two competing financial objectives for retirement defined by Dr.
Pfau: "satisfying spending goals and preserving financial assets."
He examines allocations involving six different types of investments.
Based on his methodology and assumptions, he concludes that the
efficient frontier for a hypothetical 65-year old couple consists of
combinations of stock and fixed single premium immediate annuities.
This is another excellent
paper from Dr. Pfau that should be useful in helping retirees develop
or refine their investment strategy. However, the approach suggested
doesn't appear to provide guidance on how adjustments are made in
later years for deviations from the spending plan, actual investment
experience, changes in health or changes in initial assumptions.
Perhaps he anticipates that the client and financial planner will meet
periodically to re-run the model and make appropriate adjustments.
In any case, I look forward to further research by Dr. Pfau using this
model, particularly inclusion of qualified longevity annuity contracts
in the investment allocation mix.
Wednesday, January 23, 2013
Steve Vernon
http://restoflife.com/
http://www.cbsnews.com/2741-505146_162-1348.html
I worked for many years with Steve at Watson Wyatt Worldwide (now Towers Watson). Steve is a fellow Fellow of the Society of Actuaries and is very passionate about helping people prepare for and prosper in their retirement years. Steve has written four books on retirement planning. His most recent book is entitled "Money for Life." It is an excellent book, and I'm not just saying that because he is my friend or because he refers to my website on pages 145-148 of the book. You can learn more about Steve's work on his website "Rest-of-Life.com," and I recommend that you read his excellent blog articles for CBSMoneywatch.
http://restoflife.com/
http://www.cbsnews.com/2741-505146_162-1348.html
I worked for many years with Steve at Watson Wyatt Worldwide (now Towers Watson). Steve is a fellow Fellow of the Society of Actuaries and is very passionate about helping people prepare for and prosper in their retirement years. Steve has written four books on retirement planning. His most recent book is entitled "Money for Life." It is an excellent book, and I'm not just saying that because he is my friend or because he refers to my website on pages 145-148 of the book. You can learn more about Steve's work on his website "Rest-of-Life.com," and I recommend that you read his excellent blog articles for CBSMoneywatch.
Saturday, January 19, 2013
The 4% Rule is Not Safe in a Low-Yield World
(Social Science Research Network, January 15, 2013)
The authors put what is hopefully the final nails in the coffin of the 4% Withdrawal Rule, and make a compelling argument for avoiding any "safe" withdrawal rate strategy. They conclude that, "The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio."
As noted elsewhere on this website, I agree with the authors that the 4% Rule (or some other specific "safe" withdrawal rate) does a poor job of balancing the dual needs of retirees to maintain lifestyle spending and preserve financial assets. Retirees need a spending plan that is flexible, reflects actual spending and investment experience and reflects individual circumstances (such as existence of other lifetime income through defined benefit plans or immediate or deferred annuity contracts as well as any bequest motives). Fortunately, the actuarial approach outlined in this website can help you meet these needs.
The authors put what is hopefully the final nails in the coffin of the 4% Withdrawal Rule, and make a compelling argument for avoiding any "safe" withdrawal rate strategy. They conclude that, "The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio."
As noted elsewhere on this website, I agree with the authors that the 4% Rule (or some other specific "safe" withdrawal rate) does a poor job of balancing the dual needs of retirees to maintain lifestyle spending and preserve financial assets. Retirees need a spending plan that is flexible, reflects actual spending and investment experience and reflects individual circumstances (such as existence of other lifetime income through defined benefit plans or immediate or deferred annuity contracts as well as any bequest motives). Fortunately, the actuarial approach outlined in this website can help you meet these needs.
Wednesday, November 21, 2012
Revisiting the 4% Rule
Revisiting the 4% Rule
(Vanguard, August 29, 2012)
The authors from Vanguard remind us that the 4% Rule isn't really a simple rule--the 4% rate of withdrawal needs to be adjusted for life expectancies different from 30 years and different investment mixes (as well as inflation after retirement). They also note that it is unlikely that retirees actually follow the 4% rule for their entire retirement, stating, "more realistically, retirees continue to monitor their portfolios and spending, adopting some level of flexibility to account for changes in market returns and unplanned spending needs."
The withdrawal rates contained in Figure 2 of the Vanguard paper are reasonably consistent with withdrawal rates using the spreadsheet on this website with assumptions of 5% investment return, 3% inflation, no annuity income and no amounts left to heirs. Of course, retirees with annuity income and/or plans to leave significant amounts to heirs may have to make additional adjustments to the Vanguard withdrawal rates shown in Figure 2. Alternatively, we would suggest that you simply use the spreadsheets and methodology contained in this website.
(Vanguard, August 29, 2012)
The authors from Vanguard remind us that the 4% Rule isn't really a simple rule--the 4% rate of withdrawal needs to be adjusted for life expectancies different from 30 years and different investment mixes (as well as inflation after retirement). They also note that it is unlikely that retirees actually follow the 4% rule for their entire retirement, stating, "more realistically, retirees continue to monitor their portfolios and spending, adopting some level of flexibility to account for changes in market returns and unplanned spending needs."
The withdrawal rates contained in Figure 2 of the Vanguard paper are reasonably consistent with withdrawal rates using the spreadsheet on this website with assumptions of 5% investment return, 3% inflation, no annuity income and no amounts left to heirs. Of course, retirees with annuity income and/or plans to leave significant amounts to heirs may have to make additional adjustments to the Vanguard withdrawal rates shown in Figure 2. Alternatively, we would suggest that you simply use the spreadsheets and methodology contained in this website.
Saturday, November 10, 2012
What Will $1 Million Get You in Retirement?
What Will $1 Million Get You in
Retirement?
By Douglas Carey (AOL Daily Finance, 11/9/12)
Author argues that under his assumptions and the Monte Carlo method, a couple planning for 30 years of retirement invested 70% in equities and 30% in medium duration Treasuries has an 80% probability of not outliving their $1 million retirement savings if they withdraw $55,000 in the first year of their retirement (and increase that amount by inflation each year). While his assumption for annual investment return on equities is shown as a "more reasonable" 6%, this is a real (after inflation) rate of return assumption on equities, and therefore his nominal investment return assumption on equities is approximately 9% per year, based on his assumed inflation assumption of 3% per annum. If you input a 30-year life expectancy, 7.65% investment return (70% at 9% and 30% at 4.5%) and inflation of 3%, you will get a first year withdrawal rate of about 5.9% in the spendable calculator on this website. So, a $55,000 initial withdrawal from $1 million of accumulated savings may be reasonable for a 30-year retirement period if you plan to be invested 70% in equities throughout your retirement and you believe you will achieve a 6% real rate of return on those assets. Retirees who feel somewhat less bullish about equity investments may wish to run the spreadsheets and develop withdrawal strategies based on lower real rate of investment return assumptions.
By Douglas Carey (AOL Daily Finance, 11/9/12)
Author argues that under his assumptions and the Monte Carlo method, a couple planning for 30 years of retirement invested 70% in equities and 30% in medium duration Treasuries has an 80% probability of not outliving their $1 million retirement savings if they withdraw $55,000 in the first year of their retirement (and increase that amount by inflation each year). While his assumption for annual investment return on equities is shown as a "more reasonable" 6%, this is a real (after inflation) rate of return assumption on equities, and therefore his nominal investment return assumption on equities is approximately 9% per year, based on his assumed inflation assumption of 3% per annum. If you input a 30-year life expectancy, 7.65% investment return (70% at 9% and 30% at 4.5%) and inflation of 3%, you will get a first year withdrawal rate of about 5.9% in the spendable calculator on this website. So, a $55,000 initial withdrawal from $1 million of accumulated savings may be reasonable for a 30-year retirement period if you plan to be invested 70% in equities throughout your retirement and you believe you will achieve a 6% real rate of return on those assets. Retirees who feel somewhat less bullish about equity investments may wish to run the spreadsheets and develop withdrawal strategies based on lower real rate of investment return assumptions.
Sunday, October 21, 2012
Can Retirees Base Wealth Withdrawals on The IRS' Required Minimum Distributions?
Can Retirees Base Wealth
Withdrawals on The IRS' Required Minimum Distributions?
by Wei Sun and Anthony Webb (Retirement Research at Boston)
My snarky reply to the question posed by the title of this paper is, "Of course they can, but should they?" Apparently, they used "should" in their working paper, so they felt they couldn't use it in this follow-up paper.
The authors compare several common withdrawal strategies with what they define as an "optimal withdrawal strategy." Based on their comparisons and assumptions, they conclude that the IRS rules for Required Minimum Distributions (RMDs) and a modified version of RMDs outperform the other commonly used approaches (including the 4% withdrawal rule discussed in this site).
While I'm not a big fan of the 4% withdrawal rule for many of the same reasons noted by the authors, I'm not ready to buy that RMD or modified RMD approaches are either easier to implement or more "optimal" than the approach set forth in this website. In developing their optimal strategy, the authors ignore a number of factors that may be important to retirees, including:
by Wei Sun and Anthony Webb (Retirement Research at Boston)
My snarky reply to the question posed by the title of this paper is, "Of course they can, but should they?" Apparently, they used "should" in their working paper, so they felt they couldn't use it in this follow-up paper.
The authors compare several common withdrawal strategies with what they define as an "optimal withdrawal strategy." Based on their comparisons and assumptions, they conclude that the IRS rules for Required Minimum Distributions (RMDs) and a modified version of RMDs outperform the other commonly used approaches (including the 4% withdrawal rule discussed in this site).
While I'm not a big fan of the 4% withdrawal rule for many of the same reasons noted by the authors, I'm not ready to buy that RMD or modified RMD approaches are either easier to implement or more "optimal" than the approach set forth in this website. In developing their optimal strategy, the authors ignore a number of factors that may be important to retirees, including:
- Stability of total retirement income from year to year in real dollars (or flexibility to have increasing or decreasing real income from year to year).
- Coordination of the withdrawal strategy with other sources of retirement income, such as annuities
- Desire to leave inheritance
Therefore,
while I agree with the authors that the RMD approach has the advantage (over
the 4% rule) of automatically adjusting for actual experience, there are
several downsides to this approach that may not please all retirees.
Retirees should be skeptical of any withdrawal strategy (even the one suggested in
this site) that claims to be "optimal."
Friday, October 12, 2012
Monday, October 8, 2012
Safe Withdrawal Rates: What Do We Really Know?
Safe Withdrawal Rates: What Do We
Really Know?
(Michael E. Kitces, Journal of Financial Planning)
The 4% Withdrawal Rule? Really? Is this the best advice the financial expert community has to offer? Withdraw 4% (or some other "safe" withdrawal percentage) of your accumulated savings in your first year of retirement and then blindly increase that amount for inflation for the rest of your life (or until you spend all your savings, whichever comes first). You do this without adjustment for actual investment experience, actual price inflation, changes in heath or variations in amounts withdrawn. Am I the only one who finds the 4% Withdrawal Rule crazy? If you want to self-insure some or all of your retirement, you need to use an approach (such as the one described in this website) that adjusts for actual experience.
(Michael E. Kitces, Journal of Financial Planning)
The 4% Withdrawal Rule? Really? Is this the best advice the financial expert community has to offer? Withdraw 4% (or some other "safe" withdrawal percentage) of your accumulated savings in your first year of retirement and then blindly increase that amount for inflation for the rest of your life (or until you spend all your savings, whichever comes first). You do this without adjustment for actual investment experience, actual price inflation, changes in heath or variations in amounts withdrawn. Am I the only one who finds the 4% Withdrawal Rule crazy? If you want to self-insure some or all of your retirement, you need to use an approach (such as the one described in this website) that adjusts for actual experience.
Wednesday, September 12, 2012
Fidelity Outlines Age-Based Savings Guidelines to Help Workers Stay on Track for Retirement
Fidelity Outlines Age-Based
Savings Guidelines to Help Workers Stay on Track for Retirement
(Fidelity,
09/12/12)
Fidelity issues "age-based savings guidelines" concluding that a typical person retiring at age 67 should accumulate at least 8 times final annual pay to secure an 85% replacement income in retirement.
Based on our understanding of the assumptions noted in this news release and the methodology outlined above, we have confirmed Fidelity's 8 times final pay calculation, but caution individuals who may rely on this study that one of the assumptions made by Fidelity may be overly optimistic and therefore understate the accumulated savings needed. Fidelity has assumed that accumulated savings will earn a REAL rate of return of 5.5% per annum, or a nominal return of almost 8% per year based on their assumed rate of inflation of 2.3% per annum. Individuals planning for retirement or developing spending strategies in retirement may wish to utilize a more conservative annual investment return assumption.
Fidelity issues "age-based savings guidelines" concluding that a typical person retiring at age 67 should accumulate at least 8 times final annual pay to secure an 85% replacement income in retirement.
Based on our understanding of the assumptions noted in this news release and the methodology outlined above, we have confirmed Fidelity's 8 times final pay calculation, but caution individuals who may rely on this study that one of the assumptions made by Fidelity may be overly optimistic and therefore understate the accumulated savings needed. Fidelity has assumed that accumulated savings will earn a REAL rate of return of 5.5% per annum, or a nominal return of almost 8% per year based on their assumed rate of inflation of 2.3% per annum. Individuals planning for retirement or developing spending strategies in retirement may wish to utilize a more conservative annual investment return assumption.
Friday, August 10, 2012
Can you trust retirement calculators?
Can you trust retirement
calculators?
Steve Vernon (August 10, 2012, CBS MoneyWatch)
A nice article by Steve Vernon showing that amounts produced by popular retirement savings calculators vary dramatically. Steve is an actuary I worked with for many years. He writes well-reasoned retirement articles for CBS MoneysWorth. Here is a link to his recent articles.
http://www.cbsnews.com/2741-505146_162-1348.html?tag=contentBody;correspondant
Steve Vernon (August 10, 2012, CBS MoneyWatch)
A nice article by Steve Vernon showing that amounts produced by popular retirement savings calculators vary dramatically. Steve is an actuary I worked with for many years. He writes well-reasoned retirement articles for CBS MoneysWorth. Here is a link to his recent articles.
http://www.cbsnews.com/2741-505146_162-1348.html?tag=contentBody;correspondant
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